The Federal Reserve

1
The Federal Reserve

• Or, How I learned to stop worrying and embrace
  MONETARY POLICY.

2
The Fed

• Operates as a Central Bank
• Uses the tools of monetary policy to influence
  the quantity of reserves (money) in the banking
  system
• Powerful influence over the money supply and
  general price level

3
FOMC

• Federal Open Market Committee makes decisions to
  increase or decrease the of dollars in the
  economy

4
The Fed and the Economy

• Central Banks (like the Fed) are very important
  b/c they can profoundly affect the economy
• Prices rise when the government prints too much
  money (inflation)
• Short run trade off of inflation and lower
  unemployment

5
Three Monetary Tools

• 1. Open Market Operations buying and selling
  bonds
• 2. Reserve Requirements changing the reserve
  ratio at banks
• 3. The discount rate

6
OMO

• Buying or selling of government bonds
• To increase the money supply, the Fed will buy
  bonds from the public
• Each new dollar held as currency increases the
  money supply by 1.00
• Each new dollar deposited into a bank increases
  the money supply to a greater extent
• To decrease the money supply, the Fed sells govt
  bonds to the public
• Used most often by the Fed

7
Reserve Requirements

• Regulations in the minimum amount of reserves
  that banks must hold against deposits
• They rarely change this b/c it would disrupt
  business of banking

8
How do Banks Work?

• Banks hold your demand deposits and manage them
  for you
• The behavior of banks can greatly influence the
  money supply
• Reserves deposits that banks have received but
  have not loaned out

9
T-Accounts

• An accounting statement
• If banks hold all money in reserves, they dont
  influence the money supply
• Assets the reserves the bank holds in its vaults
• Liabilities the amount it owes its depositors
  or customers

10
Money Multiplier

• the amount o money the banking system generates
  with each dollar of reserve
• It is the reciprocal of your reserve ratio
• If your reserve ratio is 10 or 1/10 then your
  multiplier is 10
• The amount of money that banks creates depends on
  the reserve ratio
• The higher the reserve ratio, the less of each
  deposit banks loan out and the smaller the
  multiplier

11
Fractional Reserve Ratio

• A banking system in which banks hold only a
  fraction of deposits as reserves
• They want to loan out some of the money deposited
  in their bank and charge interest so that they
  can make money
• Reserve ratio the of deposits that banks hold
  onto
• Reserve Requirement the minimum the Fed requires
• Excess Reserve if a bank if being conservative

12
Discount Rate

• The interest rate on loans the Fed makes to banks
• If a bank has too few reserves to meet the
  requirement, they have to borrow from the Fed
• A high discount rate discourages borrowing and
  lending